Home ownership has its own terminology that can take some getting used to. Take the term ‘equity’. It is bandied about all the time by financial experts, mortgage brokers, real estate agents, etc. Yet how many homeowners truly understand the equity principle? Are you familiar with it?
Equity is the homeowner’s best friend in terms of wealth creation. It is also the one thing that makes investing in real estate so attractive. If you have equity, you have the foundation of a stronger financial future. That’s why it is so important to homeowners.
A Basic Definition of Homeowner Equity
Equity takes multiple forms. Private equity is different from shareholder equity, which is different from home equity. As a Colorado mortgage broker and home loan specialist, Mortgage Maestro is concerned about home equity. So what is it?
The Investopedia website defines it as “the value contained in homeownership.” Investopedia goes on to explain that “the amount of equity one has in their residence represents how much of the home they own outright.”
Another way to look at equity is to compare a home’s current market value against the amount still owed on the mortgage. That amount is the value the owner actually owns outright. So to determine your equity, simply take the current market value of your home and subtract your outstanding mortgage balance. That amount is the portion of your home that you own, apart from any bank lien.
Equity Should Increase Over Time
One of the amazing things about equity is that it should increase over time. Assuming the value of your home either remains stable or appreciates year-on-year, your equity goes up. Every payment you make on your mortgage increases your equity, thereby increasing your outright ownership. Once the mortgage is fully satisfied, you have 100% equity in your home. You own it all.
The equity principle works the same way whether you are talking VA loans, conventional home loans, or any other types of mortgages. As the outstanding mortgage balance goes down, the homeowner’s equity goes up.
Why in All Matters
All of this matters because buying a home will be the single largest investment most people will ever make. Home ownership is also an investment that will pay off financially if a homeowner plays their cards right. Bear in mind that real estate prices almost always appreciate over long periods of time. There may be ebbs and flows in the market, but over 10 to 20 years, real estate prices almost always increase.
Building equity builds wealth by increasing a homeowner’s ownership share of their house and the land that sits on. Let’s say you live in a $250,000 home. Once your mortgage is fully satisfied, your house represents $250K in wealth that you own, free from any bank interest.
Should you decide to not stay in that particular home for the next 20 years, you can still use the equity to your advantage. Equity can help you purchase a new home as you climb the property ladder. It can be leveraged as a revolving form of credit. You can use equity to send your kids to college.
It’s the Extra Pay Off
First-time homebuyers just trying to survive the home loan application process may have a challenging time seeing the value of equity. If that is true for you, just know this much: equity is an extra pay off that will reap good things for you in the future. You may not have a full handle on it now, but the time will come when you truly appreciate the equity you have.